Thursday, December 2, 2010

Yesterday I posted about how the Fed has been acting as the world's central bank, and how those of us who learned from Kindleberger view this as a very good thing. But it's not just the Fed, as the other parts of the U.S. are ready and willing to step in and provide funding for Europe via the IMF:

The United States would be ready to support the extension of the European Financial Stability Facility via an extra commitment of money from the International Monetary Fund, a U.S. official told Reuters on Wednesday. ...

The remarks foreshadow a visit to Europe this week by a U.S. Treasury envoy who is expected to visit Berlin, Madrid and Paris to hold talks on the ramifications of the debt crisis. ...

The developments have echoes of the pressure applied by Washington on European capitals last May to create the near $1 trillion EFSF safety net that was last week used to rescue Ireland after its banking crisis spiraled out of control.

Given what we know about how the U.S. uses the IMF for strategic purposes, we should think of this as primarily directed at protecting the American financial sector. Just as the European Emergency Financial Stabilization Fund is primarily intended to protect the German and French banking sectors. That is, large European financial firms are heavily exposed to southern European debt, and are also counterparties of large American banks. Remember that U.S. are exposed to European banks to the tune of $3.5 trillion. If debt defaults harm European banks, this could undermine financial stability in the U.S. as well. Given that EU regulators are requiring another round of stress tests for European banks, the solvency of the European banking system is still very much in doubt. For that matter, the U.S. banking system is still quite weak.

In other words, the E.U. sovereign debt crisis is starting to resemble the Latin American sovereign debt crisis in some important ways. The response of the U.S. to both is to mobilize the IMF to shore up the system with emergency funding to the counterparties of American banks, and turn to the Basel Committee to push the costs of stricter regulatory regime onto other states. We've seen this movie before (pdf).

I've noticed some howls of complaint about this (from Facebook friends, for instance, although I'm sure it will percolate into the punditocracy soon enough). The argument goes: "How can we afford to bail out Europe, when we can't afford to take care of ourselves?" The answer is twofold: First, we can't afford not to work for financial stability around the globe. The costs of doing nothing are likely much higher than any bailout costs. If the U.S. abandons the rest of the world, the result would be disaster and chaos. Second, as I said above, U.S. actions are about the U.S., not Europe. It's not even about preserving the monetary union, or happy-go-lucky feelings that come from European integration.

A proper view includes many more dynamics than just money going from the U.S. to the E.U.